Do you really need an emergency fund?

If you follow the traditional financial advise, the recommendation is to have an emergency fund that will cover about three to six months of your monthly expenses. This recommendation is great for someone who doesn’t live below their means, but is an emergency fund really necessary for someone who lives frugally and lives below his/her means? Sandi just wrote an interesting article at Boomer and Echo that covers this topic. Her article makes me ponder if an emergency fund really is necessary.

Why Emergency Fund is Necessary (for the average Joes)

If you’re an average Joe that doesn’t have a monthly budget or doesn’t live below your means, you absolutely do need an emergency fund. When you’re spending as much as your monthly income, any surprises in life could put you into debt. Imagine that you take home $3000 a month and you spend $3000 a month. There’s no deficit but there’s also no buffer. Now imagine getting into a car accident and having to pay for your insurance deductible of $300. Since your take home income is exactly the same as your monthly expenses, you don’t have any money left over to pay for the insurance deductible. What do you do? Maybe you put the $300 amount on your credit card for the time being. Guess what, since there is no buffer in your financial lifestyle, you won’t be able to pay your credit card amount in full, forcing you into paying the high credit card interests. It may take you months to pay off your new credit card debt. If this is your financial life style, you absolutely need an emergency fund to cover any financial surprises.

Do you really need an emergency fund?

What happens to someone who lives frugally, has a monthly budget system, and lives below his/her means? Is an emergency fund really necessary? In this situation, I believe you can have a smaller amount saved in the emergency fund. How small will depend on each individual and his or her saving rate. Take the car accident example again, say your monthly income is $3000 but you only spend $1500 each month. You have a 50% saving rate and a built-in $1500 buffer each month. If you have an unforeseeable expense, like the insurance deductible, you already have the money. There’s no need to get into credit card debt because you can easily pay the amount in full. When you have a monthly saving rate of 20% or more, you’re building a good buffer for yourself. If you’re in the extreme case and have 50% saving rate or more, you probably won’t need an emergency fund.

In today’s low interest rates environment, having three to six months of monthly expenses sitting in the bank earning 1% or less interest rate just makes no sense. You’re better off investing that amount and have your money work hard for you at a higher rate. This is why I love dividend stock investing so much. For us dividend investors, the dividend received each month can also be considered as our “emergency fund.”

How Emergency Fund Works for our Household

How does this work for our household? We live below our means and have a good monthly saving rate. Part of our money management system forces us to put some money aside each month into an account called “Long Term Savings for Spending” (LTSS). This is the money we’ll use for vacations and other big item purchases. The rest of the money saved will go to purchasing more dividend stocks. In a way, the money saved in our LTSS account can be treated as the emergency fund. If we were to spend that money, it just means that we won’t have a vacation this year. Furthermore, Mrs. T and I both have maximized our TFSA and invest all of our TFSA capitals in dividend paying stocks. We also have dividend stocks in regular accounts. The dividend that we receive each month in these accounts can be used in emergency situations. In addition, we have a small amount of cash reserve that we don’t touch. That amount used to be over $10k but we’ve been slowly moving that cash reserve for dividend investing because our monthly saving rate has been going up. A high saving rate means that we are building even more buffer each month.

In summary whether there’s a need for an emergency fund depends on the individual. If you’re responsible with your finances, you most likely only need a small emergency fund or none at all. If you’re financially irresponsible, you need all the help you can get.

What about you? Do you have an emergency fund?

In case you’re wondering, Mrs. T and I do not call it an emergency fund. We believe what you focus will expand. Instead we call it an opportunity fund.

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26 Comments

  • Reply
    Martin
    August 25, 2014 at 11:09 pm

    Although I agree with you and hate having cash sitting in a low interest account doing nothing, I still would advocate for $5 – $10k reserves for large expenses. For example recently we purchased braces for our daughter. It was $5.2k out of pocket as our insurance doesn’t cover this kind of dentistry. Next I broke my ankle two weeks ago. I am expecting circa $3k deductible bill for it. So some bills may not happen for a long time or at all, but they may also occur unexpectedly and add up quickly.

    • Reply
      Tawcan
      August 26, 2014 at 9:42 am

      Hi Martin,

      Sorry to hear that about your ankle. I think in that situation it’s good to have some cash reserve around. However I don’t think your daughter’s braces should be funded by the emergency fund. That amount should have been saved. That’s just my opinion.

      Cheers

  • Reply
    Liquid
    August 25, 2014 at 11:42 pm

    No emergency fund for me either. I use the stress test strategy to prevent any probable financial disasters. Besides, Vancouver doesn’t have a systemic problem of people in their 20s and 30s living out on the streets because they have no money. Not meaning to sound inconsiderate but most homeless people either have a disability (physical or mental) or have an addiction that prevents them from making a proper living, or are simply too lazy to work. Having an emergency fund isn’t going to solve any of those problems long term. I believe if someone builds up an emergency fund they are more likely to run into an emergency lol. The universe has a funny way to give people what they set their mind on.

    • Reply
      Tawcan
      August 26, 2014 at 9:43 am

      Hi Liquid,

      Thanks for dropping by. Mentality is a big factor when it comes to personal finances.

  • Reply
    Dividend Life
    August 26, 2014 at 4:04 am

    Some interesting points there. I reached a similar conclusion about emergency funds and while I do maintain one, it’s only to be used for loss of employment. I’m slowly winding it down as a I gain more financial independence.
    Everything else such as “appliances failing” or “insurance deductible” is covered by normal savings and for the most part, I plan on appliances failing in the future and allocate money to that each month.
    Cheers,
    -DL

    • Reply
      Tawcan
      August 26, 2014 at 9:44 am

      Hi DL,

      Thanks for dropping by. I’m reaching to the same conclusion as you. But we do keep some cash reserve around just so we can sleep better at night. 🙂

  • Reply
    Dividend Mantra
    August 26, 2014 at 10:25 am

    Tawcan,

    I think it really all depends on your personal situation. A young, single renter would need much less than a married homeowner with three children.

    I personally don’t keep much around because I don’t have children, don’t own a home, am pretty healthy, have plenty of credit at my disposal, and generally keep a pretty healthy spread between income and expenses. Furthermore, my dividend income itself could provide emergency liquidity, if it were needed. Finally, I could always liquidate stock holdings if some major emergency were to befall me.

    No sense in keeping $20,000+ around for most people, in my opinion. That money could be far more useful creating wealth.

    Best wishes!

    • Reply
      Tawcan
      August 26, 2014 at 2:33 pm

      Hi Jason,

      It totally depends on the situation. For someone like you you probably don’t need much of a reserve; for someone that has a family to relay on, there’s probably a need to keep some reserves.

      Cheers.

  • Reply
    Asset-Grinder
    August 26, 2014 at 11:37 am

    All depends how liquid you are. If you are holding brick and mortar real estate then YES but if you are holding all stocks then you got some flexibility there where you can easily cash out. All depends on peoples comfort levels I say. I always keep some reserves in case things come up as they always do!

    • Reply
      Tawcan
      August 26, 2014 at 2:32 pm

      Hi AG,

      Completely agree. Stocks are pretty liquid, in worst case scenario we can always just sell stocks. It’s good to keep some cash reserves though because if you were to force to sell stocks, maybe the price isn’t the best.

  • Reply
    Henry @ Living At Home
    August 26, 2014 at 7:50 pm

    I’m currently building an emergency fund. I think it’s really important, you never know what unforeseen expenses can quickly pop up. It’s just difficult having cash sitting there and not earning anything.

    • Reply
      Tawcan
      August 26, 2014 at 8:15 pm

      Hi Henry,

      That’s great that you’re in the process of building an emergency fund. In terms of how much the fund needs it really depends on each individual.

      Cheers.

  • Reply
    LeisureFreak Tommy
    August 26, 2014 at 8:27 pm

    I always have $10K in the bank that is easy to get to and ready to use if something comes up. Even though it is dead-money as far as earning anything right now, I like knowing I won’t have to sell assets at the moment of a down market if something comes up and I need the cash for an immediate emergency or an opportunity. The amount has nothing to do with any living expense formula or factor because I stay on my fully funded early retirement budget. $10K is just an amount I prefer to use. There is no one size fits all answer.

    • Reply
      Tawcan
      August 27, 2014 at 8:28 am

      Having a fixed amount reserved is a good idea. You are very correct when it comes to selling stocks… when you’re forced to sell you’re at the mercy of the market.

  • Reply
    Brian
    August 30, 2014 at 10:53 pm

    I totally agree with everyone here. I guess it all depends on the situation. Right now I keep 6 months of living expenses in my saving account earning .95% APY. I would like to get into real estate investing and my issue is do I save for a down payment in my savings account or put it into stocks and then cash them out when I am ready to buy in a year or so. If I put too much into the market and it corrects then I wont have the down payment but if I keep the 25k in cash then I’m good.

    • Reply
      Tawcan
      August 31, 2014 at 9:01 am

      Hi Brian,

      Yes it depends on the situation. When you’re planning to buy a house it becomes even tougher to determine how much to keep in the emergency fund. Thanks for dropping by.

      Cheers.

  • Reply
    A Frugal Family's Journey
    September 4, 2014 at 1:02 pm

    We have an emergency fund…one that many would probably say is too much. But for us, I am the sole income provider and for my wife to feel safe, she has asked that we keep a certain amount aside.

    But at a certain point, when we build up our passive income streams, I plan to slowly abandon the emergency fund. Like insurance, once we have money to cover the unexpected or tragic event, we feel that an emergency fund is not really a necessity.

    • Reply
      Tawcan
      September 4, 2014 at 4:32 pm

      Hi AFFJ,

      As others have pointed out, the amount of the emergency fund is really depends on the individual. In your case having more cash in the emergency fund makes sense.

      Cheers.

  • Reply
    Scott Webster
    February 1, 2016 at 4:25 pm

    Significant difference between losing your job vs relatively small unplanned expenses, but lots of good points here.

    • Reply
      Tawcan
      February 1, 2016 at 4:36 pm

      Hi Scott,

      The key is income diversification, then losing your job may not impact as much. 🙂

      • Reply
        Scott Webster
        February 1, 2016 at 4:43 pm

        Agreed. Though if you can cover your expenses while not working… must have a fun job 🙂

  • Reply
    dividender
    February 1, 2016 at 4:27 pm

    I have an emergency fund because it make me sleep well. Knowing that when I have a setback, I can always count on my emergency fund. But if there would be a big correction I certainly would use some part of the emergency fund to invest in dividend stocks.

    • Reply
      Tawcan
      February 1, 2016 at 4:36 pm

      Hi dividender,

      That makes a lot of sense, sleeping well at night is important.

  • Reply
    KC
    June 7, 2016 at 7:36 am

    I keep an emergency fund for one reason…job loss. Twice, I got laid off unexpectedly and both times, I got caught with no emergency fund. Somehow, the bank found out (I still can’t figure this one out) and closed off my LOC. So, here I am, with only $200 in my bank account, no savings, several thousands in debt (from education), my car broke down the day after my layoff and there was a delay in my EI. My parents raided some of their savings to help me on my feet for a couple of months before my EI finally came through even though they’ve just finished having an emergency of their own.

    That got my butt into gear to always have an emergency savings account (and to never count on my LOC) and you know what? That helped me big time when once, my work temporarily shut down for a few weeks and no money was coming in but I didn’t qualify for EI during this short period of time.

    While my emergency fund is barely beating inflation, this gives me peace of mind for this reason.

    • Reply
      Tawcan
      June 7, 2016 at 10:11 am

      Some good points there KC. Thanks for your comment.

  • Reply
    Dividend for Starters
    July 27, 2016 at 1:50 pm

    I’ve lowered my emergency funds since I’ve been busy with DGI investing.

    It used to be 3 to 4x monthly expenses. After moving to a cheaper and smaller apartment it was even at 5-6x monthly expenses. Way too much if you ask me. That money has to work for me.

    That’s why I lowered it to roughly 4x, by investing more of my savings.
    Unfortunately at that point I got involved in a car accident. I owned the car – which I had driven for more than 175.000 miles – but my cheap insurance only covered damage done by me, to others. Own damage to car was not covered. As it was total loss, I had to replace it. At this very moment, the emergency fund is only 1.5x monthly expenses and I’m not comfortable with that.

    I do have some monthly buffer, but my savings rate is only ~25%. That’s why I’m prioritizing rebuilding the emergency fund, above investing at the moment. Goal is to have it back at 2.5-3x monthly expenses.

    Best wishes, DfS

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